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The reason for today’s woes is that we are victims of our own success

Joseph Stiglitz, Nobel Laureate and former chief economist at the World Bank, has hit the nail on the head. Right now, we are victims of our own success, and that is why the economy is such dire straits.

Mark Twain once said that history doesn’t repeat itself, but it rhymes. There are similarities between the 1930s and the woes inflicted on today’s global economy, but it would be pointless to over egg it, because there are lot of differences too. We are not precisely repeating the errors that led to the Great Depression and World War 2, but there certainly seems to be a pattern.

Last week, Stiglitz found himself in Barcelona delivering the 25th Barcelona GSE Lecture. He said: “Be careful using empirical findings from other periods to analyze the current situation.” But then he went on to look at the similarities, or, if you prefer, the rhyme.

The Great Depression, he suggested, was caused partly by structural transformation from the agricultural to the manufacturing sector. Today’s crisis, on the other hand, he said comes from a transformation from manufacturing to services.

“In a way, we were the victims of our own success,” said the good professor. “Productivity increases can have large distributive consequences, and standard models ignore these consequences.”

I have to say, I totally agree with him.

I have always thought it odd that the Great Depression should follow so swiftly from the greatest ever period in innovation; that is to say the period starting around 1870 and ending with the onset of World War 1. (Google Vaclav Smil’s ’Age of Symmetry 1867 to 1914’, if you want to know more about this age of innovation.)

In fact I reckon that the Great Depression was essentially caused by the innovation age that preceded it.

This is why. Innovation led to increases in productivity, but it also meant profits were channelled down to fewer and fewer people – namely the innovators and those who financed them. This led to high levels of income inequality. As a result, demand was insufficient to buy those products that innovation had created the potential to make.

There was another point, the Luddites were partially right. In the short run, the advance of the industrial age meant there was less work. In time this changed, but during the transition, unemployment rose, demand fell, and the economy was unable to fulfil its potential.

This is happening again. Sure, the nature of the innovations that are occurring are very different. A Victorian Luddite might have feared that a new industrial process for weaving would lead to job losses. The same arguments apply to modern automation, and the labour savings created by computers.

You may know that Keynes came up with the concept he called the paradox of thrift. The theory suggested that we save more in a recession, and as a result demand falls, and the recession gets worse. There are two modern day versions of this theory: the paradox of innovation, and the paradox of toil. These theories suggest that in certain circumstances – namely zero interest rates and deflation – if we all start working harder, or innovation increases productivity, the result is a rise in unemployment.

Economists are so busy denying that innovation is creating growth, that they overlook the real consequences of innovation.

But as I said at the beginning of this piece, history never repeats itself. Above I have showed how it rhymes. This is how it is different.

Right now, across the world, we have simultaneous inflation and deflation.

We have inflation in food, energy, and maybe other raw materials.

We have deflation in goods that are produced by modern technology.

I don’t have a solution here. But before you have a solution you have to acknowledge the problems. And what I have tried to do here is explain the problem.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

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Tony Brooke commented on February 27th 2013, 10:34PM

"The most noticeable recent major change in Singapore has been the large influx of manual workers from mainland China, in what seemed a reversal of past government efforts to curb over population.China watchers might do worse than look to Singapore as a working model for what is possible in future. (as Moa Tse Tung did).
"

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